Technical trading is a visual, weight of the evidence, opinion about the future direction and velocity of stock market prices. Technical analysis does not automatically exclude consideration of earnings growth and other fundamentals, but things that do not appear on the stock chart cannot have a significant part in technical trading rules. The swing trader is always more focused on the where of stock prices than the why.
Technical trading can be divided into three technical analyst skill sets:
- Breakout Trading
- Continuation Trading
- Reversal Trading
Stock, index and ETF prices seem to spend most of their time contained within identifiable price ranges. A bullish trend is defined as a continuous series of higher highs and higher lows. Even when the chart shows a clear trend from lower left to upper right most of the chart space will still be taken up with narrow, sideways price movements. Breakout trading tries to catch the price move coming out of the consolidation ranges in the direction of the trend.
Continuation trading is a subset of breakout trading. As the stock, index or ETF moves up and down within the consolidation range certain chart patterns called flags, pennants and channels tend to form on the chart. The swing trader watches these continuation patterns and takes action when the price breaks out of the pattern in the direction of the trend. These continuation signals often occur several price bars earlier than a range price breakout rewarding the trader with a potentially more profitable entry price.
The swing trader does reversal trading to try to catch the best possible entry price – the highest or lowest price bar of a swing that has reached its limit. The swing, or maybe even the previous trend, has ended and price will now move in the opposite direction.
The competent swing trader must be prepared to hit whatever the market pitches at him or at least to recognize when not to take the wild swing. Defining technical trading into these three broad categories intends to show that the technical trader needs more than a one size fits all approach to chart analysis. For example, overbought/oversold type indicators work well in range bound markets but often fail as a reversal trading indicator because a trending market can stay that way for a very long time.
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